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Stock lending and borrowing in India: The finer points explained
SLB is done through a screen based exchange traded system called SLB-NEAT. Securities on which derivatives in the F&O (Futures & Options) segment are presently available under this scheme.
Security Lending: Securities or stock lending is an arrangement in which the holder of securities agrees to loan the securities to the borrower for a given period of time on an agreement that the borrower will return the equivalent securities after that specified time period. It gives the lender the opportunity to earn incremental return on idle portfolio.
Security Borrowing: Securities borrowing, is the opposite of lending, in which the borrower who does not have the securities borrows from the lender for a specified period of time on an agreement to return the equivalent share to the lender after that specified period. The borrower participate in SLB to reap the benefits of the market sentiments.
Lending fee: Under SLB scheme, the lender earns a fee and the lending fee is quoted as per share basis. It is quoted on the basis of annualized yield expected by the borrower or the cost that the borrower is expected to pay.
Tenure: The tenure for SLB transaction is up to 12 months. 12 fixed monthly tenures with fixed reverse leg settlement (return of securities by the borrower to the lender date) dates are available in SLB.
Early reacall option: The lender has the right to early recall the securities before the end of the loan period and can be entered up to 3 days before the reverse leg settlement day. In this case, the lender has to specify the lending fee to be forgone for the balance period. If the order is matched, then the settlement is done in T+1 day (where T is the Transaction day).
The borrower after borrowing the securities from the lender gets the full title for the term of the loan and requires the borrower to provide the lender a collateral.
Why do investors participate in securities borrowing?
Well, one of the main reason for borrowing and lending securities is short selling. Short sellers borrow the stock from the lender in order to sell them and again buy back the stocks when the prices are high. So, they make a profit after paying the lending fee.
Click here to know more about short selling of share.
We also know about the arbitrageurs who try to make profit from price differences in the spot and futures market by making simultaneous trades offsetting each other and capturing profits.
Now, if the arbitrageurs find that there is a huge discount in a stocks futures compared to its spot price they try to capture that price inefficiency to make profits.
In order to do so, arbitrageurs sell the stock that they borrowed from lenders and then buy the stocks futures immediately. So, by this they make a profit after paying the lender the fee. However, this can take place only if the futures settlement and the settlement period for stock lending and borrowing match each other.
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